On Our Radar

On Our Radar

Pension, Bondholder Cuts at Core of Detroit Plan

Detroit has circulated a financial plan that requires significant concessions from its pension funds and bondholders and declares that an interest-rate obligation that helped drive the city into bankruptcy is a disputed claim that is not part of the settlement.

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The plan also calls for creating a regional water district to shift other costs.

The proposals, described in a copy of the plan obtained by Reuters on Friday, are a major step in Detroit's historic bankruptcy case, a blueprint for how Emergency Manager Kevyn Orr proposes to treat more than $18 billion in debt and long-term liabilities.

After months of negotiations with creditors, it essentially sets terms for what could be a settlement of claims and could put pressure on Detroit's thousands of creditors to accept the proposed deal or face costly litigation.

The ultimate resolution of the bankruptcy will rely on Detroit restructuring its debt, bringing in contributions from philanthropic foundations and the state of Michigan, offloading some of its obligations to a new regional water authority, and issuing about $1.36 billion in new debt. Roughly 28 percent of settlement funds would go to pensions and 25 percent would go to bondholders, according to a source with knowledge of the negotiations.

"It's a moving target, and this has not been settled," said the source. "It's very complex. It's like six levels of chess while playing tennis," the source added.

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The creation of a new Great Lakes Water Authority, which will pay the city $47 million a year during a 40-year lease of the city's share of water facilities, is a major part of the plan. The new authority would assume all pension liabilities owed to current and former Detroit Water and Sewer Department workers.

Detroit would stop using its money to make payments to its police and fire pension funds, as well. Instead, those pension contributions would come from $470 million pledged by philanthropic foundations and the Detroit Institute of Arts and a proposed state contribution of $350 million.

Detroit also would swap out the Detroit system's $5.3 billion of water and sewer bonds for new debt issued by the regional authority on a dollar-for-dollar basis.

To help fund its financial settlements with bondholders and other creditors, the city would issue $837.9 million of unsecured notes.

Detroit's plan to issue new debt to pay creditors was seen as questionable by some analysts in the U.S. municipal bond market. "The description of the plan merely digs Detroit into a deeper hole with creditors, further jeopardizing the city's ability to sell bonds and borrow needed funds to repair their infrastructure and improve the city's ability to provide stable essential services for the safety and welfare of its citizens," said Richard Larkin, director of credit analysis at HJ Sims & Co.

Craig Elder, senior fixed-income research analyst at Robert W. Baird & Co, said he was not sure how Detroit would be able to sell debt unless it was insured. The city already defaulted on payments due to bondholders of its pension and general obligation debt, leaving bond insurers to make the payments.

The yield on some Detroit general obligation bonds spiked to the highest level since November, at 7.8 percent, in secondary-market trading on Friday. A year ago, two months before Orr was appointed by Michigan's governor to restructure Detroit's finances, the bonds yielded 5.12 percent, reflecting greater confidence among bond investors.

Orr presented the proposed debt adjustment plan, required as part of its Chapter 9 municipal bankruptcy, earlier this week on a confidential basis. He still is at odds with pension funds over how large a cut they should take.

On one key aspect, the city's controversial interest-rate swaps deal with investment banks Merrill Lynch Capital Services and UBS AG, the city declares the contracts as a disputed claim and does not include them as part of the settlement plan.

The city also reserves a right to protect its share of taxes on casino revenues from any claims by the two investment banks. The revenue had been pledged as collateral for the swaps.

Different classes of creditors are offered a wide range of options. The proposal allows holders of some classes of general obligation bonds full repayment of their claims against the city. Some holders of $1.45 billion of debt sold in 2005 and 2006 to fund the city's pensions would receive only 40 percent of the face value of their securities, plus a share of new notes issued by the city.

Specifics of the city's plan for reduction in pension benefits are not detailed in the copy of the proposal obtained by Reuters. The plan includes language about concessions, but in many places, dollar figures are left blank.

Jordan Marks, executive director of the National Public Pension Coalition, criticized the plan's treatment of public employee pensions.

"If the city fails to pay the pension funds anything short of what they are owed, it will mean painful cuts for firefighters, police officers, and thousands of other municipal workers, who earn an average $19,000 per year in retirement," he said. "Big banks, however, will feel little pain as Wall Street posted record profits in 2013."

Barry HoAire, portfolio manager of Bel Air Investment Advisors, in Los Angeles, said bondholders may oppose the favored treatment of pensions. "It's clear they're proposing a more favorable outcome for pensioners," he said. "There is going to be a lot of back-and-forth, and I just don't think this is going to be accepted by bondholders.

The city makes clear that it intends to move forward even if it cannot win agreement from all classes of creditors. In a so-called "cramdown" provision, Detroit asks bankruptcy Judge Steven Rhodes to approve the plan even "in the event that any impaired class does not accept or is deemed not to accept the plan."

Bill Nowling, a spokesman for Orr, did not respond to requests for comment.

(Reporting by Bernie Woodall in Detroit; Additional reporting by Steven C. Johnson, Hilary Russ in New York, Lisa Lambert in Washington and Karen Pierog in Chicago; Editing by David Greising, Stephen Powell and Dan Grebler)side n